Opinion: Why a Fed rate hike now would be ‘March madness’ to stock investors

The Federal Open Market Committee is set to meet on Tuesday and Wednesday to assess the U.S. economy and interest rates. But while the spotlight now is on the Federal Reserve, investors may not see much from Janet Yellen & Co. this time around.

And ultimately, that may be a good thing.

Investors are caught between two competing desires for Fed action: On one hand, Wall Street wants rates to stay low given anemic economic growth and the risk of deflation globally. Yet other investors want the both U.S. economy and stock market to stand tall without the “drug” of constant stimulus and easy-money Fed policy.

For now, the low-rate crowd holds far more sway. The bottom line is that investors don’t want a rate hike and the economy has a long way to go before the Fed can responsibly move interest rates higher.

If you want a clear indicator of just how little investors want a rate hike, check out the CME Group’s FedWatch tool that has predicted a 0% chance of a rate hike. The indicator, which is based on 30-day Fed Fund futures, had a zero probability of a rate hike as of Friday and just a 20% chance of a rate hike for the next FOMC meeting in April.

That jibes with what the bond markets have been saying. In February, the 10-year Treasury
TMUBMUSD10Y, +0.13%
briefly hit a three-year low and even now yields just under 2%.

In fact, the Fed itself seemed to telegraph it would be standing pat on interest rates in the minutes from January’s FOMC meeting that were released several weeks ago: “Several participants noted that … waiting for additional information regarding the underlying strength of economic activity and prospects for inflation before taking the next step to reduce policy accommodation would be prudent,” according to the minutes.

That’s about as clear as Fedspeak gets, and investors have taken those words to heart.

Of course, the Fed minutes reflect some troubling economic figures. There are hints that overleveraged energy companies that are not the only pressures on credit markets. The Bank for International Settlements recently noted that outstanding debt securities in the fourth-quarter dropped by the largest amount in three years, which “may signal a turning point in global liquidity.”

Furthermore, while the headline U.S. unemployment rate of 4.9% is encouraging, remember that controlling inflation is the other half of the Fed’s “dual mandate.” And the inflation picture is far less rosy, with the U.S. inflation rate at 1.3% as of January’s PCE Index reading, well below the 2% target stated by Fed officials. And furthermore, that comes after the PCE Index hit its lowest levels since 2009 late last year.

Consider that the European Central Bank just cut rates again precisely because the specter of deflation and falling prices returned in February. The Federal Reserve would need to be incredibly confident to move in the opposite direction, and the inflation numbers don’t support that.

Investors would go bananas if the Fed raised rates in an environment like this, further restricting credit and placing downward pressure on prices.

The Fed can’t justify a rate hike — yet

Even if the Fed wanted to go against expectations and ignore some of the data, Chairwoman Yellen could lose a lot of credibility with other central bankers and economists if she moved rates higher at a time like this.

After all, the U.S. is enough of an outlier in this era of accommodative monetary policy. Japan pushed rates below zero in January, and just a few days ago the European Central Bank pushed rates deeper into negative territory along with other stimulus measures. Even smaller economies are increasingly dovish, such as New Zealand surprising markets with a rate cut recently.

That’s because the world has learned a lot in the last few years — particularly regarding deflation and double-dip recessions after the 2011 European debt crisis.

In 2011 the European Central Bank boosted rates despite credit markets on the brink, leading to a dreaded “double dip” recession for the eurozone. The ECB backpedaled from its increases and began to steadily cut rates in November 2011, but it was too late — the eurozone economy was already in decline, and would continue to contract until mid-2013.

I would love to see an environment where rates could move higher and the economy could support it, but this isn’t the case right now. And given this, it seems prudent to hunker down for a continued near-zero interest rate environment in the short-term, and probably even medium-term.

That means interest-rate risk for longer-term bonds isn’t perhaps as acute as some may have feared six months ago, and investors can continue to hold their bonds with relative confidence that they won’t take a significant hit.

Also, the low-rate environment should support some of the premium valuations in dividend stocks, given that any megacaps yielding around 3% are delivering more income than Treasurys right now. That creates a floor for companies such as Johnson & Johnson
JNJ, -1.27%
. The health-care giant has a stellar credit rating and a 2.8% dividend, which has helped drive up its shares about 16% in the last six months, while the S&P 500
SPX, -1.04%
is up about 3%. Similarly, consumer staples giant Procter & Gamble
PG, +0.25%
, up 20% in the last six months, with a current 3.2% dividend.

Of course, all stocks carry risk and there is no sure-thing even in powerhouses like J&J and P&G. But given that rates are going to be stuck near zero and the global growth picture is so weak, health-care and consumer-staples stocks seem the safest place now for your cash.

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